Closing Down a China WFOE: You Can Run But You Can’t Hide (Part 2)

When closing down your China WFOE, don’t run and don’t hide. Just follow China’s company liquidations rules and you will be just fine. (photo by ZS, http://bit.ly/1P7Mrtf)

This is part two of our post on shutting down a WFOE in China. In Part 1, I discussed what you need to do to close a China WFOE properly. In this post, I discuss the repercussions of failing to properly shut down your WFOE.

Failure to properly liquidate a WFOE results in a number of penalties that can be imposed on the management and the shareholder(s) of the company. As a basic rule, the legal representative and the other directors (but not the general manager) are personally liable for any damages caused to creditors by the WFOE’s failure to strictly comply with China’s WFOE liquidation requirements. This means that abandoning a WFOE is a big mistake if the WFOE is in debt to anyone. Abandoning a WFOE automatically pierces the WFOE’s corporate veil, leading to personal liability for the WFOE’s legal representative and its directors. In a nice twist, the shareholders are off the hook in this situation.

When proper liquidation is not completed, the first step by the Chinese government is to put all of the potentially liable parties on a “black list.” This includes the legal representative, the directors and the shareholders. Though the general manager is technically not liable, the name of the general manager often goes on the blacklist as well. The WFOE’s failure to pay its taxes, failure to pay its employees and failure to pay a major creditor are also normally noted on the blacklist. The blacklist is issued to all SAIC (State Administration for Industry and Commerce) offices in China and it also typically goes to the PRC border control authority as well.

The effect of being placed on this blacklist is usually the following:

1. The legal representative will not be permitted to act as a director, manager or supervisor of a Chinese company for a period of three years from the date of the WFOE’s revocation.

2. The shareholders of the WFOE will not be permitted to invest in another Chinese company for a period of three years from the date of the WFOE’s revocation.

3. The name of the WFOE cannot be used for a period of three years from the date of revocation.

The above is the result when the WFOE does not owe any taxes, fees, salaries or debts to creditors. If the WFOE is abandoned owing any taxes, fees, salaries or debts, the situation is far more serious. In this situation, the PRC authorities have the right to criminally prosecute the legal representative and the directors of the company for having failed to make the required payments. Failing to pay taxes and fees is a crime in China and failing to properly liquidate is also a crime when the result of that failure means that creditors were not properly paid as provided by China’s WFOE liquidation rules. Note that this is not treated as an administrative or civil violation; failing to follow the liquidations rules by failing to make the required payments is a crime.

As you can see, even when no crime has been committed, it is difficult or impossible for a person or entity named on the blacklist to engage in investment or company management in China. In these cases, where a name appears on the list, it is not uncommon for the border authority to refuse entry for the named person. This is particularly common in Shenzhen for persons entering the PRC from Hong Kong. If a crime has been committed, the result is more serious. If significant amounts have not been paid, then for any person named on the black list, denial of entry into China is common. Even worse though is when China allows this person to enter China and then immediately arrests him or her for remand to the local authorities for prosecution. We also have heard of many instances where key WFOE personnel were held essentially under house (hotel, actually) arrest in China until their debts were fully paid. See The Single Best Way To Avoid Being Taken Hostage In China and Maybe Owe Money to China? Don’t Go There.

Fortunately, the process for proper WFOE de-registration and liquidation has become more systematic and easier to handle in China. The Chinese authorities have learned that their cumbersome and expensive de-registration procedure was only encouraging Chinese and foreign company owners to abandon their company registrations. The local governments have recently streamlines and systematized the de-registration process. For Chinese companies (including WFOEs) that have paid their fees, do not owe taxes and have paid their employees, de-registration and liquidation is now a relatively straightforward process that does not need to be approached with fear.

Bottom Line: You can run but you cannot hide. If you need to shut down your China WFOE, follow the rules. There is no alternative.

Steve focuses on assisting foreign companies in doing business in and with China. He prides himself on working in the “real” China: the world of factories, fish plants, and farms that lie outside of Beijing and Shanghai. Having mastered the Chinese language and legal system, Steve’s unique expertise makes him an invaluable resource to our clients.

With rules like this, the whole idea of limited liability for a company becomes meaningless. There is no difference then between sole proprietorship, partnership and limited company if all outstanding liabilities have to be paid off when a business fails in the normal course of business. The corporate veil is just a sham then..

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About China Law Blog

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.